"ECONOMIC MANAGEMENT AND THE BUDGET" ByThe Development Institute (TDI)Team of Consultants

May 17, 2003

​​IntroductionThe IDP was the first to debunk the notion that we can speak about Stabilization without simultaneously speaking about Economic Growth. While the subscribed notion was that Government needs to stabilize the economy first and then speak of initiating growth measures, the IDP insisted that these are two sides of the same coin.

In a similar vein, the IDP points out that to speak of the Budget we must simultaneously speak about economic management. This is not to say that Budgets have traditionally said anything about managing the economy. Rather it is to recognize that the challenge to the Budget in the current crisis is twofold:a) There is the challenge of closing the gap between revenues and expendituresb) There is also the challenge of sustaining a stable fiscal position.

The challenge of closing the budgetary gap is essentially an exercise in arithmetic. Government needs to rearrange its expenditures and revenues in such a manner that a neutral budget balance can be achieved at some clearly foreseeable future. For the current annual budget this is a policy decision being dictated from sectors outside of the domain of the IDP. The risk is measured by accuracy of official prediction of the revenues from each of the additional fiscal measures.This would be the only risk if our only concern were the productivity of the fiscal measures in the current year. But what happens next year? Do we expect to repeat the same measures and receive the same level of external budget support? Would these measures yield the same revenue volumes especially if they themselves are likely to destabilize the current fragile economy?It is clear that fiscal stability in the coming years will depend more on how we manage the economy than on the specific fiscal measures we introduce at the start. Thus credibility of the Budget requires both getting the numbers right in year one and managing the economy better in years two onwards.

Economic ManagementWhile closing the Fiscal gap can be expressed as a clear-cut policy action, the actions required for managing the economy so that it would grow in spite of the fiscal measures are not. Increasing private savings and investments are all decisions that individuals make based on their assessment of the future prospects for the economy not the present state. Entrepreneurs decide, on the basis of their interpretation of the changes in the macro-economy, when and how to utilize their private resources in the pursuit of “growth objectives”. It is important that the planning process (read measures directed at managing the economy) and the budget preparation process both recognize this phenomenon.Chapter 3 of the IDP states the three principles of the Economic Planning/Management as follows:a) Transparency: particularly in expenditure policy and expenditure-control policyb) Accountability: particularly in budgetary allocationsc) Inclusiveness: sharing information to ensure that all major economic actions form a coherent approachThe IDP recognizes two real tests facing Government. The first is to achieve its objectives of closing the fiscal gap. The second test is to increase the productivity of whatever little public sector investments it manages to secure. It is worth repeating, for all who may have missed the second test that there is an abundance of evidence[See Footnote 1]to support the position that fiscal adjustments can have a positive effect when public investment is protected and its productivity increased[See Footnote 2].

The IDP therefore seeks to achieve a high level of coherence between public sector investment and private sector initiatives and sets out two conditions for this to be achieved within the components of the Budget:a) Public Sector initiatives (including the corporate plans of Ministries) must find their justification in an integrated development plan which defines national prioritiesb) The expectations upon which the private sector makes its investment decisions, are based on predictable public sector instruments and results.

Furthermore, since the stated objective of the Integrated Development Plan is to allow all stakeholders in the national community to share in the responsibility for the management of the economy at the broadest level of society, then the IDP, to be consistent, had to include explicit measures to involve stakeholders in the formulation of the budget. The Strategy for Debt RecoveryThe fundamental issue of the Budget is how it proposes to address the issue of Debt Recovery which is the cause of the deteriorating fiscal deficit. The IDP proposed a plan of five initiatives[See Footnote 3]:

The first initiative is to seek short-term debt relief.

The second initiative is to enhance internal surveillance and assessments of the impact of both domestic and external debt.

The third initiative is to develop a Code of Financial Management Practices.

The fourth initiative is to rebuild the confidence of the financial sector.

The fifth initiative is to establish fiscal transparency

The Budget Statement can be expected to explain the conditions under which the first initiative of short-term debt relief is to be achieved. But the statement has to go much further than this for two reasons. The first is that, in the current situation in Dominica, donors have expressed concern at providing short-term relief without a credible exit strategy.[See Footnote 4] Donor support is a critical first step in this walk to recovery and the IDP attempted to preclude any difficulty in this regard by proposing initiatives 2 and 3.The 3rd initiative is very important. It proposes that Government prepare study on the post-IMF debt management policy and extracts from this strategy a “Code of Financial Management Practices”. In other words, we should detail our future management practices and turn them into a current proposed Code. These are all measures aimed at presenting a credible “exit strategy” to those who would assist us.The 5th initiative addresses the instrument for “inclusive management of the economy”, the Medium-Term Public Expenditure Framework (MTPEF). This is also detailed in the IDP. However, it is worth repeating that this framework would require the Ministry of Finance to compile three matrices:

Macroeconomic Framework : a quantitative matrix of basic economic indicators projected over the next 3 years.

Matrix of Priority Actions organized along the major themes of the growth and development strategy.

Matrix of Public Expenditure Allocations to Priority Actions projected over a 3-year roll-over period

Managing Growth in the EconomyThe Budget would also have to detail how it envisions managing the resurgence of growth in the economy. The IDP proposes three growth models. The first is the export growth model, which would combine the support of the Social Recovery Strategy (European Union funded SFP) in the Banana sector, with guidelines for Tourism[See Footnote 5] to have the impact needed from a leading sector, and building on local initiatives. This is the immediate short-term initiative.

​​Broadening the participation of income earners in the tourism industry​

Build on investment initiatives identified by local “development committees”​

​Promote human and investment capital formation expenditures in response to local area (village councils) planning initiatives.

The second growth model is a more medium-term growth model. It targets human resource development in terms of labour and entrepreneurial skills and medium-term investments in education and wellness of the population at large. This model can be supported by the Social Investment Fund (detailed in the IDP) as it brings civil society into the management of economic growth.

Target the CARICOM Single market (as our extended domestic market) to export these skills or import them as opportunities in the country reveal themselves.

NGOs and other civil society organizations to target migrating health and education professional workers to support the systems they have left behind through remittances in cash or material and technology support;

Promoting income-earning activities at a broad level of society.​​

The third is the Social Recovery Model.This model responds to the current situation in which demand is lagging, farmers have lost significant incomes and rural and urban poverty persists.This model can be built on specific measures that may be identified in the Poverty Reduction Strategy Paper.This paper is an essential step for accessing concessionary IMF funding.

1.3.The Social Recovery Model

Income support on the demand side to boost family incomes of the poor and not-so-poor,

The provision of education and health services under the social recovery programme which will rebuild the human resource component.

Support to enterprise initiatives

Establishment of rural support enterprises

To complete the management of economic growth, the IDP also identifies the specific risks to economic recovery. These are the possible events or situations, outlined in the IDP, which have the potential to seriously dislocate economic activities in the near future.The potential economic triggers are:a) Market displacement of our exports due to imposition of “soft infrastructure” rules**;b) General deterioration of soil quality affecting agricultural production.c) Migration of productive capacity in the major manufacturing enterprise.d) Trade Policies forced into conformation with WTO Trade regulationse) Preparatory concessions for accession to larger regional trade blocks, FTA.

The potential natural disastertriggers are:a) Hurricanes and Tropical depressions impacting on settlements, infrastructure and on production;b) Localized geological events such as major land slides into rivers and subsequent flooding (e.g. Layou River incident)c) Health-related events such as HIV/AIDS, and highly communicable diseases.d) Severe seismic activity reflecting earthquake and volcanic activity.

**Note: Soft infrastructure rules refer to rules that importing countries may impose on the exports from developing countries. These include both ensuring compliance with specified health, hygiene and safety conditions as well as specifying the technology that may be required to satisfy the importing country that compliance has been achieved.

A Budgetary Requirement to Understand the SituationBudgets are expected to change as circumstances change. Indeed, the Budget is expected to reflect the understanding by the officials of the fundamentals of the economic situation. The truism is that “The Budget must understand the Situation and not the situation should understand the Budget”!Besides providing an extensive “Situation Analysis”, the IDP also sought to shed light on three other aspects critical to any future Government Budgets. These are:a) The Changing Role of Government Intervention.b) The Planning Framework for promoting Economic Growth.c) The Social Investment Fund, extra-budgetary funds and local area investments.

The Changing Role of Government InterventionSince the Budget is Government’s intervention in the economy, the IDP explains what in its view is the changing role of Government intervention. Once again, the symbiotic relationship between the Budget and Economic Management is expressed in the need for a joint concern for both the “Public Sector Balance Sheet” and the “Private Sector Balance Sheet”.

While the Fiscal Adjustment measures would require a reduction in the level of public sector intervention (reduced expenditures/increased taxes), Government also has to demonstrate sound management of the economy through policies to increase local business competitiveness and establish private sector priorities in the national agenda. The IDP seeks to provide a framework to integrate both of these approaches.

Changing the Planning FrameworkThe second contention is this. If economic growth is truly a fundamental of the stabilization programme, then the programme cannot be based solely on official development assistance and public sector investments. Dominica has to face the challenge of mobilizing additional sources of investment funds from “non-budgetary sources”.It becomes necessary to widen the concept of the Framework for promoting economic growth. The task of lowering the average cost of social and economic investment funds continues to be legitimate. However the planning framework must also include bringing investment capital to a wider cross section of the population through the “Extra-Budgetary” funding programmes.[See Footnote 6]Simultaneously, Dominica should seek to involve the emerging “local area development committees” and the local government units in planning local area investments, which would contribute to increasing the human, social and economic capital base for economic recovery.​Social Investment FundThe Social Investment Fund is a very important concept that can be easily misused if it is not structured within three other policy goals:a) Promoting Local Area Concept plansb) Supporting Local Development Committeesc) Reorienting Local Government towards attracting investments into their area.

The Social Investment Fund differs from any other development intervention in that it does not pre-determine the specific nature of investments to be carried out in any community but rather establishes a multi-Sectoral range of investment options. Depending on the particular social fund, communities can express their priorities in two ways;a) They can form a community project committee and develop a project proposal,b) They can submit a project proposal through a local intermediary agent such as the local government, an NGO, the PTA at a local school or some other grass-roots organization.

These mechanisms contrast with the more centralized investment choice model in which a central Ministry or central planners alone determine the size and location of public investments. This decentralized form of publicly-supported investment selection is “demand driven” to denote its derivation from a local set of preferences and actions that emerge more closely to, if not directly from, the beneficiaries themselves.

The overall development objective of the Social Investment Fund (SIF) is to provide funds (grants, revolving loans and guarantees) to local development groups, community organizations and NGOs to fully participate in the supply of basic social and economic infrastructure and services.

The Social Investment Fund has very serious implications for the Budget and for increasing public sector savings:

It can become an instrument for targeting social and economic investment as well as for sharing both the costs and the responsibility for implementing some social investment projects.

It can become a source of funding that is relatively independent of the budgetary priorities dictated by the Government and can be run by a Board of Directors responding to the development needs of other stakeholders,

Government can increase the level of resource mobilization of the Fund by seeking donor support for either the SIF or for project components in the SIF outside of the framework of its own mutual obligations to bilateral and multilateral funding sources.

The SIF can become an effective instrument for maintaining the focus of the various non-budgetary funding opportunities on the major themes of an Integrated Development Plan.

While it is expected that, in seeking to get the arithmetic correct the Budget is likely to reduce some social investment/maintenance expenditures, the SIF allows us to transfer the responsibility for some of these expenditures to local authority and local groups who can mobilize funding through the SIF.

The overall project development objective is to improve access of those groups at risk of economic exclusion to basic social and economic infrastructure and services, by supporting small-scale projects, identified and implemented through community participation. The project's components include: community sub-projects sponsored by eligible NGOs and CBOs for demand-driven investments in:

education, health/nutrition,

small scale infrastructure,

natural resource conservation,

agriculture productivity,

afforestation,

social capital,

gender/ women and their empowerment

Social Investment Fund fits in very well with the other programmes such as DFID promoting “pro-poor growth” in that it can be designed to assist the poor (and not-so-poor) to capture more benefits from economic growth. The leverage of the poor is too small to force market forces in their favour.

The SIF will seek to increase the role and responsibilities of communities in the subproject cycle development, including subproject management, and strengthening promotion mechanisms.

The warning is therefore important that the Social Investment Fund not be treated as a new panacea for the woes of expenditure contraction as this would result in a total disaster.

Footnotes:​[1] “Expenditure Composition, Fiscal Adjustment, and Growth in Low-Income Countries” by Sanjeev Gupta, Benedict Clements, Emanuele Baldacci and Carlos Mulas-Granados. IMF Working Paper WP/02/77 , April 2002.[2] See also the discussion on Fiscal Adjustment in Chapter 3 of the IDP.[3] Details of these initiatives are to be found in Chapter 6 of the IDP, and can form the basis for funding requests for programme support, studies or technical assistance.[4] Notes of the Donor Meeting April 29, 2002.[5] The IDP notes that Tourism has to involve more stakeholders if it is to have the same effect that banana exports did in 1989 with EC$104 million earned by over 8,000 farmers.[6] The IDP identifies ten “extra-budgetary” programmes such as the Basic Needs Trust Fund, Banana Trust Fund, Social Recovery Strategy, Dominica Rural Enterprise Project (DREP), etc. Indeed, the Budget may seek to have some of these funds re-financed with a change in objectives consistent with the IDP.